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Mutual Funds and Mutual Fund Investing - Fidelity Investments

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Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event.

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In this lesson we discuss the importance of being diversified across maturity dates when investing in individual bonds. Bond ladders, barbells and bullets are three strategies that may help you achieve this.

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Building a portfolio of fixed income funds starts with identifying your investment goals, then understanding how different types of bond funds align with those goals.

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This lesson will introduce the use of annuities as a tool in your portfolio. Please take special note of the pros and cons section.

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Evaluating bond funds does not have to be complex. By using a few factors you will gain insight into risk and return, which will then give you a feel for the fund's future volatility and return.

Retirement income strategies

You've spent your entire working life saving for retirement. And while saving is important, the way you manage your retirement savings could be even more important. That savings, after all, typically becomes your income—and shifting from a saving mindset to a spending one can be difficult for many people.

Building a retirement income strategy starts with a realistic look at what you'd like your retirement to be like—and what that lifestyle will likely cost—establishing your priorities and understanding the tradeoffs of each option. That can result in something of a balancing act for your emotional as well as financial life. There is no one-size-fits-all retirement, and as such there's certainly no one-size-fits-all retirement portfolio. But most retirees should consider their investments through the lens of 1 of these 4 categories:

Growth potential: It's important that the growth of your investment portfolio outpaces inflation, but you should balance that need for growth against the risk of exposing your savings to excessive market fluctuations.

Guaranteed income: Investment returns fluctuate—often significantly. But certain insurance products, including Treasury bonds, Certificates of Deposit, and fixed and variable annuities, can provide an income stream and help you prepare for retirement with greater certainty. Annuities, however, may come with fees and withdrawal penalties that can limit your flexibility should an unexpected need arise.

Flexibility: Having access to and control over your assets is important for some, but flexibility usually means giving up a stream of income.

Principal preservation: Knowing that your investment is safe can help you sleep at night, but investments that aim to preserve your principal,1 such as money market funds, CDs or Treasury bonds, come with a different sort of risk. These investments generally offer relatively low yields—and your principal might not be large enough to generate enough income from interest or dividends to fund your desired retirement lifestyle. Plus, if you invest too conservatively, your savings may not grow quickly enough to keep pace with inflation.

Building retirement income strategies

While there are a number of ways to maximize your retirement assets, here are 4 of the most popular.

The first is for people whose assets are large enough or they have enough in terms of other income from a pension, Social Security, or another source that they do not need to draw down principal.

1. Interest and dividends only

If you've accumulated enough savings, it may be possible to use income generated by your portfolio to meet all of your retirement income needs. A typical portfolio could include bonds, bond funds, CDs, and dividend-paying stocks.

Pros

Minimal risk to principal if you're investing in FDIC-insured CDs2 or US government bonds3

When assets invested in bonds or CDs mature, the entire principal is returned to you4

Cons

The need to roll over bonds and CDs at maturity complicates long-term income projections because it is impossible to know future interest rates

Limited investments in stocks could leave you exposed to inflation risk

A heavy allocation in bond funds or dividend-paying stocks could expose you to increased market risk

By using a portion of your assets to purchase an annuity, you add an element of certainty to your retirement income strategy. An annuity is a long-term investment that comes with an insurance contract that guarantees a stream of income.

Pros

Annuity income can be guaranteed for life—so this strategy can help cover essential expenses and manage the risk of outliving your savings

You can choose a fixed income annuity or a variable annuity:

Fixed income annuities provide a set payment each annuity income date; using additional assets, you can also purchase a feature—commonly referred to as a cost of living adjustment (COLA)—that will increase your payments each year to help your income keep pace with inflation

Variable annuity payments fluctuate based on market performance and have the potential to help protect against inflation

Because an income annuity can provide a guaranteed source of income, you may be able to invest the rest of your portfolio with an eye toward growth

Cons

You may give up some control over a portion of your savings

Expenses associated with an annuity could be higher than other types of strategies

Income from the annuity might not be sufficient, causing you to draw down your other savings more than you'd like

4. Short-term bridge

If you need some additional income for a period before full retirement, you may also want to consider using some of your assets to fund a short-term bridge strategy. Perhaps you will not be receiving Social Security or drawing on a pension or 401(k) immediately after you retire. Or, maybe you expect additional expenses due to a more active early retirement lifestyle. To help you "bridge" the gap, you might consider investing a portion of your portfolio in a way that will produce enough income to cover the gap, while investing the remainder for total return.

See how this strategy might work for you by testing out some Model CD Ladders. You can choose from a 1, 2, or 5 year CD ladder.

Pros

A good way to generate an income stream for a fixed time period

The total return portion of your portfolio may produce enough growth to protect against inflation

Cons

Assets invested in total return strategy may be exposed to market risk

You must make certain that the assets in your total return portfolio will be adequate to cover your retirement income needs following your bridge period

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Fixed Income at Fidelity

Whatever your investment goals, Fidelity can help you find a fund to match.

Before investing, consider the investment objectives, risks, charges, and expenses of the fund or variable annuity and its investment options. Contact Fidelity for a prospectus and, if available, summary prospectus containing this information. Read it carefully.

Investing in a variable annuity involves risk of loss - investment returns, contract value, and, for variable income annuities, payment amount are not guaranteed and will fluctuate.

Fidelity Income Strategy Evaluator is an educational tool.

1.You could lose money by investing in a money market fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund's sponsor has no legal obligation to provide financial support to money market funds and you should not expect that the sponsor will provide financial support to the fund at any time.

2. For purposes of FDIC insurance coverage limits, all depository assets of the account holder at the institution will generally be counted toward the aggregate limit for each applicable category of account. FDIC insurance does not cover market losses. For more information regarding FDIC coverage, please consult www.fdic.gov.

3. Treasury securities are backed by the full faith and credit of the U.S. government for the prompt payment of interest and principal at maturity.

4. Subject to the credit risk of the issuer.

5. Guarantees apply to certain insurance and annuity products and are subject to product terms, exclusions and limitations and the insurer's claims-paying ability and financial strength.

Displayed rates of return, including annual percentage yield (APY), represent stated APY for either individual certificates of deposit (CDs) or multiple CDs within model CD ladders, and were identified from Fidelity inventory as of the time stated. For current inventory, including available CDs, please view the CDs & Ladders tab.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.